One Size Finally Fits All

Although a one-size-fits-all solution isn’t likely, I can certainly promise we will get to a better, more integrated state. How and why we will get there, though, won’t simply be organic. Industry changes are coming, in my view. The implications of that will be higher, not lower price tags, but you will get what you pay for.

Too Many Players

Today there are currently too many players in this space. Why? Because firms build the system and sell it for great profits to the highest bidding private equity firm. It is no secret that a few software vendors have fetched nearly $1 billion on a fraction of revenue. Their EBITDA multiples have been rather large – I’m not talking 5-7 EBITDA, but more like EBITDA multipliers in the teens.

Combine the CTRM and ETRM spaces into C/ETRM, and we have a space race. The space to occupy the leadership board, sell, and move onward is no doubt on many software vendors’ minds. We are all wondering who will be around and who won’t.

I will, however, make a public bet that we will not have so many different software classes, or bolt-on software products ten years from now. That is almost a certainty. Expectations and rapidly changing markets will force horizontal integration, without fail.

It’s both the vertical and horizontal integration that is likely the great debate. Outsiders consolidating this space is a possibility I will save for the end of this chapter.

In the interim, there are too many CTRM and ETRM firms cross-pollinating each other’s space. Weak commodity prices are not the reason for it, nor will it make any difference, because we simply have too many firms.

Therefore, expect consolidation to begin sooner than later. Expect that an up-and-comer will evaporate, as will at least one, if not two, old-school players literally succumb, then sell.

If your software is one that is consolidated into a larger company, is that good for you?  It could be.  And, it could be your software versions are about to become obsolete, and discontinued.

On the other side, expect another up-and-comer to rise to the top.

As I said in the beginning, I am not divulging who, and certainly not why in this book. I have a formula, though, of what has been successful in this industry, who is developing what, why, and the differentiation between these firms – which at times appears subtle but at others, more obvious.

As for horizontal integration, the project expectations have not been met with a supposed one-size-fits-all approach. Untold, brilliant clients have attempted this approach. It does not work.

At least two, if not four or five of the software system classes I mentioned above, are needed to bring a commodity or energy trading and risk management system project to fruition with both basic tools and basic reporting, but also with all of the physical and financial needs, sophisticated valuations, logistics, and accounting aspects on the table.

Markets are too volatile, and with untold vendors and untold consulting firms running around suggesting this system and blocking that up-and-comer, a breakthrough is inevitable and trust is a big issue in this industry today. Period, end of story. Trust is an issue.

In public, I wouldn’t be so forthright, but in a book that you are reading, we are simply having an eye-to-eye conversation. For many, we will have that conversation directly as well.

Why, then, is consolidation taking longer than one would expect? Traders are not the only A-type, oftentimes AAA-type, running in our markets. Smarter-than, better-than, and get-out-of-my-way attitudes are ever present in the software space, like no other too.

There is a difference, though, between tenacity and winning.

Issues in consolidating the C/ETRM space stem from some of the issues I point to, especially, in the last chapter of my last book, Energy Trading and Risk Management. The trading strategies, so to speak, of certain software vendors, in trading lingo is ‘long’ and ‘short’ the opposite of what the best trading strategy of all time has produced!

Consolidation

Consolidation, though, may happen through organic development. Certain firms recognize the trajectory and are adjusting. They may become self-made, although some already claim that today, and the rest of the story will play out in the coming years.

As this one unfolds, there is speculation that outside influences are noticing the valuation this commodity and energy software space has brought onto itself in the last few years.

There are thoughts, too, that big software firms see the commodity and energy space as nothing more than additional transactions to process, not real differentiation. This means they either start buying up firms or they claim they can do commodity and energy trading and risk management because it all tastes the same – like chicken.

Unfortunately, chicken can be prepared in a variety of ways, and if they don’t have that canary checked for bird-flu, someone is going to get more than an upset stomach. I understand the thought that a trade is nothing but a transaction – it is. But what I am not sold on is that big software vendors, without buying the right flock, will be able to deliver any better than the rest. Especially if they send in non-trading experts.

That is where the issues are today – knowledge about trading. This industry is not short, but really, short trading and risk knowledge in all facets.

Big Software Players

Beware, they are coming for this space. How they do it may be surprising. By buying C/ETRM firms, or by developing the capability in-house? Both.

Their approach does make sense in that many of these players are going to existing clients and selling the solution as an add-in component or suite of commodity and energy trading capabilities, from front-2-back. This is logical and probably some quick, easy wins that they leveraged from existing clients. Clients have already paid hundreds of millions, to well into the billions. I know, I have worked in a variety of capacities in accounting projects from $30 million to $1.6 billion.

For clarity, these big software players do not sell C/ETRM price point projects. Their business models have been to sell to large corporations who can pay the billion-dollar price tags. This means they did not walk into an existing client and offer a $2-5 million-dollar C/ETRM-like software products. They charge much more, and they know with certainty they cannot just show up into the traditional C/ETRM space and offer these immaterial sized projects, as they see them.

No doubt, they have a long horizon to leverage their current client base to build, or rather have them pay for, their R&D for the C/ETRM system capability. A good move.

Buying a C/ETRM vendor and folding it into their big software generally seems, to me, to be a better approach. Because the EBITDA multiples of the past, they continue to build, rather than buy. Somewhere, consolidation prices will balance.

Why and how do I provide this suggestion?

I have hinted, and will speak further, to the talent in the commodity and energy space. I have been in the commodity and energy trading arena for a long time and I see really smart college graduates showing up with 3.9 GPA’s from well-known colleges. I have discussed with many how long it takes for someone to get up to speed to be effective in working on software engagements.

I know how long it takes for someone who is hired straight out of college to work in a narrowly-defined area of trading, say for the mid-office. Based on that input, and my experience, professionals take three years, and many often take more than that to really digest energy trading in their specialty. To provide consulting services, add 2-5 more years.

According to Malcolm Gladwell, it takes 10,000 hours to become an expert at something. That is five years of work. With the shortage of knowledge in our space, I don’t know how a great big software firm can put forth a one-size-fits-all C/ETRM suite and sell it for much more, save they are selling it to existing clients who have big wallets.

I have worked on three separate accounting software projects, two of which were large. I have seen that they all had many of the same hurdles to overcome. It is prudent to surmise that growing pains are organically absorbed, and maybe, in respect to the size of the client and the C/ETRM function in relation to the rest of their business, expectations may yet still create a positive perception for their clients.

Perception within our space, amongst C/ETRM firms, varies widely. Ask someone from periphery risk or logistics systems, and there are choice words I would not share here amongst our own brethren. Some founded, some really not. Perception, rather than truth, though, is what people see. The truth only comes years later, just as I experienced with my relatives after leaving Enron.

If a mega software firm wants to purchase and integrate a C/ETRM vendor, or class thereof, a traditional C/ETRM system is the best choice, rather than attempting to build-out the commodity and energy space in-house. A hard one to discern again, but if you are able to go to an existing client who paid you $1.6 billion for your accounting system, another $125 million for an energy suite is just an add-in. Or, a $435 million previously implemented ERP system and asking another $35 million, may seem more easily achieved than buying a C/ETRM system for a proposed $18 million.

Standardized Software Platforms

Small- to medium-sized firms have found tremendous value in having the up-and-coming C/ETRM vendors provide a standardized platform that is much easier to implement and maintain.

Standardized being that each system has every client on the same version; no separate branch codes. These companies, depending on their niche and/or stage of growth, may also provide some customization, but it is usually to address the critical path of a transaction – not the Triple-A approach of giving you the any, all, and automatic software solutions the larger firms desire. Balancing the must-haves and the nice-to-haves with cost, is how many of these standardized software firms are able to deliver crisp solutions.

There are many firms who have purchased the major C/ETRM systems that should have definitely explored this avenue. There are also many firms today who are using bigger platforms, who may want to consider these solutions as an experiment for one segment of their business.

If you look at these up-and-coming software vendors’ websites, you will see they have small players, but you will be surprised too, that they have large trading houses on their client list. There is no doubt some large players are leveraging and experimenting with standard software.

The Ultimate Future State

In the next five years, for the client who can no longer afford to lag, the choices are challenging. If you are waiting for the AAA – any, all and automatic – system capability, you will get replaced with someone who has started experimenting and who bought a system. The increase in big data needs and more complex sophisticated valuation tools that interact seamlessly with logistics are the keys going forward. Integrating these key factors into a core transaction processing system will follow.

There are definitely those who think this will be achieved sooner than 2020, and it is possible. Although we are changing at a faster pace, it still takes time to get where we all want to be.

We will get there though. By 2030, there will be no more than 3-5 major C/ETRM firms, plus the up-and-coming firms. Consolidation, fading into the sunset, and large software firms will dominate. Those that remain will be a legacy existence, with half-baked support, if any at all. A few up-and-coming firms will actually be one of the last standing, but if they don’t also have the back-end accounting capability, they will be absorbed or vanish as well.